Outsource the Board?

Here’s a novel idea: outsource the board of directors. This article from The Economist reports on a concept outlined in a recent law review article that takes the notion of “professional director” one step further. Boards of directors obviously play a critical role in the corporate world, but, according to the article, their records “might politely be described as mixed. The first decade of the 21st century produced an embarrassment of dismal oversight, from the Enron and WorldCom scandals of 2001-02 to the financial crisis of 2007-08.“ The head of a major investment firm has opined that “’I actually don’t think risk management failed….I think corporate governance failed, because…the boards didn’t ask the right questions.’”

One frequently cited problem is that CEOs “have packed boards with cronies…and sidelined critics….” But, although legislation has promoted more board and board committee independence and governance advocates have campaigned for board diversity, “some magic bullets have proved to be blanks. Everyone thinks independent directors make better board members but there is no academic evidence to prove it. When Lehman Brothers went bankrupt, eight of its ten directors were independents. These reforms have left the basic problem untouched. Companies have almost always been admirably ruthless when it comes to reinventing themselves. They have experimented with every imaginable organisational form and have contracted out everything from manufacturing to strategy-making. Yet when it comes to boards they have been astonishingly conservative.” According to the article, boards continue much as they have for the last 100 years: “Board members are part-timers with neither the knowledge nor the incentives to monitor companies effectively. And they are beholden to the people they are supposed to monitor. Boards are thus showcases for capitalism’s most serious problems: they are run by insiders at a time when capitalism needs to be more inclusive and are dominated by part-timers at a time when it needs to be more vigilant about avoiding future crises.”

To address these fundamental issues, two professors suggest a more fundamental fix: outsource the board function to a new category of professional firms, BSPs or Board Service Providers. This new type of professional-services firm would provide services as professional directors in much the same way as law firms or management consultants provide their services, with the expectation that professional directors would be better monitors of corporate performance. The concept is that BSPs would “supply the company with a full complement of board members. It would also furnish it with its collective expertise, from the ability to process huge quantities of information to specialist advice on things such as mergers. Companies, they point out, would never buy legal services or management advice from people only willing to spare a few hours a month. Why do they put up with the same arrangement from board members?“

The professors’ contention is that this type of board “would replace today’s nod-and-a-wink arrangements with a market in which rival BSPs compete. It would create a new category of professional director. And it would allow BSPs to exploit economies of scale to recruit the best board members, introduce more rigorous training programmes and develop the best proprietary knowledge. Now, even the most diligent board member can only draw on his or her experience. BSPs would be able to draw on the expertise of hundreds. This would increase the chances that corporate incompetence will be corrected, corporate malfeasance found out and corporate self-dealing, in the form of inflated pay, countermanded.”

The article recites a number of objections to the outsourcing proposal: it might eliminate board participation by “genuine outsiders” with “industry-changing ideas”; professional board members might be too conservative when advising on strategy; conflicts of interest would be created if competitors used the same BSP; shareholders would not be able to nominate directors (In the few cases where that might happen now). One suggested compromise proposed in the article is to have a hybrid board “in which the BSP filled a majority of board positions and a minority were reserved for others.” But there are certainly other issues to consider, including these: if management has a role in selecting the BSP, why wouldn’t the BSP be just as “beholden” to management as the current crop of “cronies” is to the CEO? Could the problems inherent in “group think” be exacerbated by this approach, e.g., a BSP that fails to detect a problem besetting an industry would fail to detect it at many companies, not just one or two? What about the loss of genuine hands-on experience that some directors bring? What standards would be set and qualifications required for “professional directors” that would distinguish them from current directors? How would success or failure of a BSP be determined under ordinary circumstances and who would make that determination in the context of dismissal or reengagement of a BSP? What accountability or duty would BSPs have to shareholders, who are the owners of the company? What would happen to ISS? (Just kidding.)

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